When federal employees are trying to choose a time in their life to retire, there is often some confusion because there are so many factors to consider.
We often hear that 62 is the “magic” age for FERS employees to retire. Have you ever wondered why?
Let’s break it down: There are three potentially significant incentives for FERS employees to wait until the age of 62 to retire. We’ll also cover some natural by-products of waiting longer to retire.
1. Social Security
First, the most obvious incentive to wait until age 62 to retire is that Social Security is immediately available at that time. The vast majority of FERS employees will be eligible to draw at age 62 because they’ve likely had a whole lifetime of work where they were contributing to Social Security.
Now of course, just because you can take Social Security at age 62 doesn’t necessarily mean you should. There are planning strategies to consider when deciding when to turn on Social Security benefits. When we have someone who is at least age 62 when they retire, that gives great flexibility to start that income stream from Social Security if they really need it.
There’s a lot that goes into the decision to start Social Security. The argument could be made that you should take it right away at age 62 when you’re first eligible (and subsequently receive it for a greater number of years). Many people feel this way because they are uncertain about the ability of the Social Security program to pay out full benefits in the future.
However, a similar argument can be made that you should wait as long as possible to draw Social Security benefits so that you get the highest monthly payout available to you. Under this scenario, although you may forgo the earlier years of drawing benefits (from age 62 – 70), when you do begin drawing at age 70 it is at the much higher amount.
An important point of clarification: The date you retire from federal service does NOT have to be the date you draw Social Security benefits and vice versa.
Remember, everyone’s strategies for drawing Social Security are going to vary based on their overall financial situation, available income streams in retirement, tax situation and personal circumstances.
2. FERS Retirement Formula
The second reason that age 62 is such a magic number for a FERS employee to retire has to do with the formula used to determine how much your retirement check is going to be. Of course, you want to do everything you can to make sure those retirement checks are as high as possible.
Let’s start with the standard FERS retirement formula. This is the formula to calculate how much your retirement check is going to be. Most employees have at least seen this formula although you might not know all of the different components. In the FERS pension formula (for regular employees), we take the employee’s high-3 average salary multiplied by 1%, then multiplied by their number of years of creditable service.
Here’s where the magic happens: If we can get a FERS employee to wait to retire until at least age 62 with at least 20 years of service, they move to a 1.1% formula instead of that 1% formula.
Now I know when I first saw this, I said, “Big whoop! 1% vs. 1.1%. What’s the big deal?” But that’s a 10% raise in your retirement check (a check that is paid to you for the rest of your life)! That could be a big game-changer for many FERS employees considering retirement, and it may be just the right incentive they need to keep working for another year or two until they qualify for this higher formula.
3. Cost of Living Adjustment (COLA)
The third reason why it is so beneficial for FERS to wait until 62 to retire has to do with when a retiree’s pension is going to begin to rise. Most employees are familiar with what’s called a COLA, or a Cost of Living Adjustment in retirement. For regular FERS retirees, COLAs begin at age 62. For regular CSRS retirees and FERS special provision retirees (Law Enforcement Officer, Firefighter, or Air Traffic Controller), COLAs begin right way regardless of retirement age.
Each year, the Bureau of Labor Statistics releases a number called the Consumer Price Index for Wage Earners, or the “CPI-W” for short. The CPI-W is based on a number of economic factors – essentially, measuring how much more expensive things are today compared to last year.
If a retiree is eligible to receive a COLA in a given year, the COLA happens automatically. We say COLAs happen “automatically” because this increase does not have to pass through Congress, and it does not pass the President’s desk, like a pay raise would. The CPI-W number is released in October and that increase simply goes into effect the following January – but only for those eligible to receive it.
Now, let me give you an example of a regular employee who retires at the age of 57 under FERS. So presumably, they have at least 30 years of service which would make them fully-eligible to retire at that age. If they decide retire at age 57, that would mean for ages 57, 58, 59, 60, and 61, their pay has not changed at all. That’s right – their pay has stayed flat for 5 years until it finally begins to rise at age 62. That is 5 years of compounding that will never be recouped.
It’s scary how detrimental “flat” income can be to a retiree’s ability to keep receiving the amount of money that they need to survive. In this example, this retiree’s pay has simply not kept up with inflation, yet everything around them got more expensive! To try to solve this problem, they can end up dipping into accounts like their Thrift Savings Plan and depleting those funds too quickly. This is a slippery slope when you put too much of a demand on an account like TSP early in retirement as it drastically increases the chance you will run out of money in retirement.
Getting COLAs applied to your pension right from the very beginning can make a significant difference in the long run. Unfortunately, sometimes employees are so eager to retire, that they may not even realize how important those incremental increases are until the damage is already done.
Additional Benefits to Working Longer
Aside from the topics we discussed above, there are some natural by-products to working longer. This is true for CSRS or FERS employees as well as those in the private sector. On the surface, most people realize that the longer they work, the better off they are – at least financially speaking.
But have you given serious consideration to the financial impact of continuing to work a few more years? Aside from working until age 62, we’ve highlighted some key ways below that you can benefit by working longer than originally expected.
Keep getting your full paycheck
The first reason to keep working is that you will continue to receive a full paycheck (not the significantly lower retirement check). The longer you work, the fewer years you have to worry about supporting yourself in retirement. This may mean that once you finally DO retire, that you can live a more comfortable retirement with more freedom to spend your money.
Increase your high-3 calculation with pay raises
The next benefit to working longer is that your pay continues to rise with annual pay raises, promotions and step increases. Typically, the longer someone works, the higher their pay rises. This increased pay changes the high-3 calculation used in their pension formula and yields a higher pension.
Add extra years of service into the pension calculation
The longer someone works under CSRS or FERS, the more number of years that will be included in the pension calculation. Let me give you some numbers to put this into perspective. Let’s say we have a FERS employee who has a high-3 of $100,000. For every extra year they work, it adds another $1,000 a year to their pension per year.
To my point earlier, if they’re at least age 62, with at least 20 years of service, and they continue to work extra years, it’s adding $1,100 a year to their pension because they are on the higher 1.1% formula. It can be pretty impressive how much more you can receive in retirement by continuing to work another year or two or five, depending on what your situation is.
Save more in TSP
When an employee continues to work, they can continue to save more in the Thrift Savings Plan because they have more time (and income) to contribute. If you make $100,000 per year and you contribute the maximum allowable amount (which for 2021 is $26,000), plus your 5% salary match (for FERS), you would amass an extra $31,000 in TSP for every extra year you decide to work. That can add up fast.
Increasing the Social Security Benefit Payable
The longer you contribute to Social Security, the higher the benefit is likely to be. Your benefit is calculated based on the highest 35 years of lifetime earnings. Therefore, the longer you work at the higher pay levels, the better your benefit calculation will be when you decide to turn on this benefit.
Keep Other Costs at Bay for as Long as Possible
There are some benefits – such as the Federal Employees Group Life Insurance (FEGLI) – that are designed to get more expensive in retirement. Other programs like the Survivor Benefit Plan, do not begin until retirement, so premiums won’t start until you retire. Ultimately, the longer you wait to retire, the longer you can put off those higher premiums.
And then of course from a financial planning standpoint, the longer you work, the fewer years you have to think about providing income for yourself in retirement.
Know Your Numbers Before You Retire
When it comes to retiring from federal service, you must know your numbers. Ultimately, how much income do you need and how much income do you have available?
Step 1: Draft a retirement budget and know what expenses you are likely to have in retirement. Remember, while some expenses go away in retirement, some appear or get much more expensive.
Step 2: Map out all of your possible income sources. That income might come from the federal pension itself (CSRS or FERS pensions), Social Security, the Thrift Savings Plan (TSP), your spouse’s 401(k), or other investments or annuity products that you might have out in the private sector.
Everyone’s situation is unique, and it’s important to consider your retirement goals before making a final decision on when it’s time to retire. You need to make the best choice for you – but it’s important to know your options first. Look at the big picture and make a retirement plan with a financial professional. Regardless if you decide to wait until age 62 or later to retire, be sure you understand your options so you can make the best decision for your personal circumstances.